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Decision-making TechniquesRisk and UncertaintyExpected ValuesRolling BudgetsSyllabus Area C

ACCA · Question 32 · Decision-making Techniques

Section C

MetroGrid Power is a public utility transitioning to renewable energy. They must choose one of three infrastructure upgrade options. The Net Present Value (NPV) of each option depends on whether the government passes a 'High Subsidy' or 'Low Subsidy' green energy bill.

Probabilities: High Subsidy = 0.6, Low Subsidy = 0.4.

Payoff Table (NPV in $ millions):
Option A (Solar Focus): High Subsidy = $50m, Low Subsidy = $10m
Option B (Wind Focus): High Subsidy = $40m, Low Subsidy = $25m
Option C (Mixed Grid): High Subsidy = $35m, Low Subsidy = $30m

MetroGrid currently uses an annual budgeting process but is finding it too rigid given the rapid changes in renewable technology and government policy. The CFO has proposed switching to a Rolling Budget.

Required:
(a) Calculate the Expected Value (EV) for each option and recommend which option MetroGrid should choose based strictly on EV. (6 marks)
(b) Discuss the limitations of using Expected Values for this specific decision. (6 marks)
(c) Evaluate the CFO's proposal to switch from annual budgets to rolling budgets, highlighting the behavioral and operational impacts on MetroGrid's managers. (8 marks)

How to approach this question

For (a), multiply payoffs by probabilities and sum them. For (b), remember that EV is an average, ignores risk, and relies on estimates. For (c), define rolling budgets and contrast the operational benefits (up-to-date) with behavioral drawbacks (too much work).

Full Answer

Expected Value is a useful quantitative tool but has severe limitations for one-off, high-stakes decisions because it masks the spread of risk. Option A and B have the same EV, but A is much riskier. Rolling budgets solve the problem of outdated annual budgets in fast-moving industries, but they introduce significant administrative burdens that can demotivate staff.

Common mistakes

Recommending Option A over B without realizing they have the same EV, or failing to mention the 'one-off' nature of the decision in part (b).
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